The Freehold Premium – How much is forever really worth?

I like to emphasize that, much as property analysts and realtors often talk in terms of dollars per square foot, the average home-buyer is less inclined to dwell on these numbers. Affordability to them is more a factor of price quantum rather than the per square foot cost. Do I have enough cash/CPF funds to make the downpayment and can my income support a loan of this quantum? These are the more pertinent questions at the top of a typical buyer’s mind. This is precisely why developers have done such brisk business hawking pseudo-homes the size of broom closets (ie. mickey mouse/shoebox apartments of 300-500 square feet)! Buyers of such units were obviously so taken with the lower price quantum that they failed to notice/ disregarded the exhorbitant premium they were paying in terms of $ psf!

Consider this – a unit of 1055 sft at Alexis sold for $1,327 psf in April this year. Just 3 days prior to this transaction, a 388 sft Mickey Mouse unit there was sold at $1,806 psf, or a whopping 36% premium! Talk about being taken for a ride!

A typical “Mickey Mouse” apartment in Singapore is a whole lot less cheery than this rental villa courtesy of http://www.fla-villa.com.

Which makes me wonder, why are property buyers here so ready to squeeze themselves, or their prospective tenants, into tiny wee apartments, when they cling to the idea of buying freehold like their lives depend on it? Call me strange, but given a limited budget, I would choose a comfortably-sized home for 99 years over squishing my family into a broom closet till-death-finds-us-keeled-over-from-deep-vein-thrombosis-sustained-via-overly-tight-bedroom-walls any day!

Yes, it’s generally true that leasehold properties take a harder hit when times are bad. But when the market is buoyant, all price tags head north, whether 99, 999-year, or freehold, so you can still make good capital gains on a leasehold provided you sell at the right time. Consider this when you’re making a decision on your next property investment – Businesses often fail not so much because the underlying business is bad per se, but because of poor cash flow management. Likewise, consider your investment as your business, and the rental/loan installments as the +/- cashflow. All things being equal, a prospective tenant is not going to pay you more rent on your freehold property than he would for an otherwise similar 99-year property. Say you paid 20-30% more for freehold, then naturally the monthly loan installments are going to be that much heavier. It’s basically as though you’re operating a business with that much higher overhead costs than the guy who bought a cheaper leasehold apartment.

When interest rates start climbing from 1.3% to say 2.6%, the effects are going to be quite profound. To determine whether your business is “safe” or not, I would use guidelines similar to what banks use for their loan approvals. Take your loan quantum, and calculate what the monthly installments would be at 3.45%pa interest, this will be your conservative “cost projection”. Then take the current median market rental for your unit and slash it by 30%, this will be your conservative “revenue projection”. Then see whether the potential shortfall between your cost and revenue projections is something you can comfortably pay every month for at least 1-2 years.

Now, the lawyer in me is going have to make a disclaimer at this juncture – the above guidelines are just my personal view, and different people will have different levels of comfort, so feel free to make your own assumptions and form your own guidelines. The figures I’ve suggested are just something for you to consider.

The point I’m trying to make it this – Yes, freehold prices will almost always outperform leasehold prices, but leasehold properties will move in tandem with freehold when prices are on the uptrend. The best weapon you can have in your quest for property investment success (or at least avoidance of failure) is holding power. Holding power allows you to time your sale during the most ideal market conditions and avoid being forced to sell during unfavourable times. The peaks and troughs of the market become non-issues to you when you are able to comfortably hold your property through any storm. And a major part of holding power is determined by the net cash flow of a property investment, which is likely to be stronger for the cheaper leasehold investment than the freehold one. Of course, if you have two similar properties at the same price, it makes sense to pick the freehold one over the leasehold. In fact, even if the freehold is say $200 psf higher, it would make sense to pick the freehold, assuming that this $200 psf equates to a 10% or less premium, for a reasonable apartment size of say 1,000 square foot, ie. $200,000 more to “upgrade” from leasehold to freehold.

I’m going to leave the discussion of just how “forever” Freehold really is for another day…